Tax Credits for Energy Efficiency and Green Buildings: Opportunities for State Action
Report Number	E021
Author Info	Elizabeth Brown, Patrick Quinlan, Harvey Sachs, and Daniel Williams
Details	Executive Summary States play a fundamental role in addressing energy use and the adoption of energy efficiency measures at the regional and local level. States can provide tax incentives that foster technology options matched to the needs of their residents. This report describes the current status of energy efficiency and "green buildings" tax incentives that states offer. Our goal is to assist state policymakers in designing and evaluating their own programs by providing insights about current programs in other states. A properly designed state tax incentive has both short-term and long-range benefits. In the short run, the incentive can effectively increase market share of an advanced technology or practice that otherwise would be harder for the state's residents, businesses, and other organizations to find. By itself, the state's action increases the visibility of the technology or practice and validates it with the state's credibility. Greater market share launches a "virtuous circle:" As market share increases, more market actors (salespeople, specifiers, installers, etc.) become vested in the technology or practice because it can be more profitable than the status quo and can increase customer satisfaction. This vestment induces more firms to enter the market and the resulting competition can drive down prices and further increase market share. At some point, market share is large enough that the technology or practice is clearly cost-effective and has broad support from those who profit from it. By then, a state tax credit is no longer needed and building codes and other regulatory mechanisms can be revised to make use of the technology or practice mandatory. State-funded energy efficiency incentive programs increase consumer choices by inducing innovation in the private sector. The programs thus benefit state energy, economic, and environmental objectives. The private sector needs encouragement to provide products and services that address broader energy security, system reliability, environmental, and economic goals. In particular, market failures limit private investment in cost-effective efficiency measures; for example, projected returns may be lower than for other, non-energy investments or technology deployment timeframes may be too long. Tax credits can accelerate customer acceptance and increase market share for high-efficiency products and services. Benefits accrue to the state and its residents, the United States and its citizens, and the global climate. Both the federal government and a number of states enacted tax incentives during the 1970s. However, evidence emerged that these early tax credits had relatively little impact on consumer behavior, for several reasons: low efficiency requirements for eligibility led to large "free rider" expenditures; the credits tended to be small; they lacked promotion; and they had excessive administrative requirements. To maximize effectiveness, tax incentives should target cutting-edge, very high-efficiency technologies or practices that customers might not find otherwise. The incentives should be large enough to affect decision-making, while reporting requirements should be just stringent enough to make fraud insignificant. Table ES-1 shows the states with energy efficiency tax incentives for the private sector. This report only briefly addresses other state initiatives to promote efficiency investments. These alternatives include utility demand reduction programs, public benefits funds, direct state appropriations, and programs to assist with efficiency improvements in publicly owned buildings. Conclusions State tax incentives for energy efficiency are a relatively new way to promote technologies that provide benefits to both residents and the state overall. The incentives have been well received in Oregon (the state with the longest running program) and initial results in Maryland and New York are promising. Carefully designed tax incentives work in two ways. · The tax credit validates the technology or practice with the credibility of the state's endorsement. By itself, this raises interest in the product and reduces the usual skepticism about emerging technologies. · The actual incentive, if it is the "right" size, is a powerful motivator for purchasing decisions. Maximizing effectiveness requires attention to detail in program design. · The "right" incentive size is important. A sales tax incentive of about $0.50 on a $10 compact fluorescent bulb may not motivate sales, while the same 5-6% sales tax waiver on a $500 appliance may be a strong incentive. · The threshold for credits must be at a high performance level, but one that is available in the market. Too low a performance standard increases program cost without significantly changing the market. · Budget effectively. Allow enough money for effective marketing and program evaluation. Consider revenue loss caps. Effective programs have ranged in cost from much less than $1 per resident annually (appliance sales tax waivers) up to about $10 per resident annually for Oregon's very broad-range set of business and residential programs, combined. In Oregon, when the programs proved both popular and effective, they were removed to allow further growth. · Programs must have long enough duration (probably 5-10 years) for credits to affect the market. · In some cases, programs will be more effective if they allow choice among recipients of the credits. For example, if tax credits for highly efficient or green buildings can only be taken by building owners, the programs are essentially unavailable for government, religious, and educational buildings. Allowing construction firms or others in the buildings industry to take the credit as part of their job compensation will increase interest. · Complement other policy initiatives (federal, municipal, and public benefits); The impact of these factors is suggested by looking at one successful program. Oregon has no sales tax, so the state's leverage at the point of sale is very limited. However, Oregon offers substantial income tax credits for purchases of specific products and provides point-of-sale support to increase interest. For example, purchasers of condensing furnaces with electronically commutated motor (ECM) furnace motors are eligible for a $350 income tax credit. This is an important signal: First, it is about 10% or more of the purchase price. Second, Oregon is validating the dealer's efforts to "sell up" to premium equipment that has greater customer benefits. In contrast, a sales tax incentive for compact fluorescent bulbs is a small amount, typically much smaller than the price variation among stores, and is less likely to have incentive value beyond the state's endorsement. Energy efficiency tax credits enacted in other states can serve as starting points for new legislation, but a common theme we observed is the importance of considering the specific needs of the state in designing legislation. Tax credit programs should be tailored to individual state economic, energy and environmental objectives. The most common energy efficiency tax credits are green buildings tax credits and efficient appliances credits. These programs offer large opportunities to encourage energy efficiency while minimizing lost revenue. Further, because other states have already used these approaches and programs are already in place, adapting the programs used in those states is generally easier and more effective than developing new approaches. Many state programs lack specific funding for implementation and evaluation of the programs. Even if intended to provide greater funding for the credits themselves, a complete absence of funding for implementation and evaluation inevitably threatens the long-term viability of the programs by robbing them of adequate marketing and the ability to learn from experience and demonstrate success. Adequate annual allocation for tax credits is important for their success. The purpose of a funding cap is to keep the programs affordable for the state, but if the caps are too low, then the credits will not allow the market to grow to desired levels. An adequate cap will create a level of incentive that encourages use of the credit and therefore gains the benefits of increased energy efficiency without harming the state. Several factors influence the success of legislative efforts to enact financial incentives for energy efficiency investments. These factors include: · Broad support for energy efficiency measures by multiple stakeholders; · Model legislation and state programs that can be adapted for use in the state; and · The fiscal capability of the state. An effective plan for designing a state tax credit program must consider these factors and target specific measures that have the greatest potential. In most states, green buildings measures and efficient appliances measures are the dominant themes. Using the model language in Appendix A of this report, new legislation can be crafted that is effective, properly sized, and properly evaluated. Recommendations Based on the research compiled in this report, we offer the following recommendations to create effective state tax credits to encourage energy efficiency. · Efficient product sales and income tax credits. Several states have launched programs encouraging the purchase of high-efficiency appliances, vehicles, and equipment. Sales tax rebates are the lowest cost of the tax credits and are attractive because of their administrative ease. First, they are implemented primarily at the retail level, involving only staff training to sell a product that is more profitable for the retailer. Second, selection of products is on a pass/fail basis, i.e., either the product is eligible or it is not. Choosing products is also easy since other states have already set guidelines or the federal ENERGY STAR program can be used as a baseline. Model legislation for sales tax removal for energy-efficient products can be found in Attachment A. · Green buildings tax credits. Encouraging resource efficiency in the building industry has large payoffs in that there are many opportunities for energy and monetary savings. These programs have higher costs associated with them than the credits above and require setting regulations or using a third-party scoring system, such as the Leadership in Energy and Environmental Design (LEED) ratings system. Model legislation for this credit is located in Attachment A. We recommend that the following aspects of tax credit legislation deserve legislative focus: · Funding for implementation and evaluation. The best designed programs will not encourage market change without good market implementation. Funding for these activities should be included when developing a program. Planning for periodic evaluation of the program is also very important. Evaluation results can be used to identify appropriate program adjustments to enhance the program during implementation and also can assist other states to develop programs that build on the lessons learned from current programs. An alternative might include performance incentives for participating agencies. · Sunset dates. The goal of these program is to accelerate adoption of advanced technologies in the market. We recommend that each program have a "sunset" or expiration date, or a provision to tighten qualifying levels in order that credits continue to spur market development for energy-efficient innovations. · Appropriate funding caps. To be effective, tax credits must have an appropriate level of funding while not causing excess lost revenue to the state. We recommend setting qualifying performance levels that correspond to the upper few percent of the market, perhaps 5-10%. For emerging technologies, identifying the level of market penetration is never easy and will require discussions with market players and other stakeholders. The attached model language suggests appropriate caps for the green buildings credit and could be adapted for efficient product credits. The scale of caps ranges fairly widely. Maryland's appliance sales tax waiver costs roughly $0.20-0.40 per resident annually. More comprehensive programs are likely to cost about $1 per resident per year. At the high end, the very comprehensive suite of residential and commercial incentives in Oregon costs about $10 per person per year but has been so popular and effective that the state currently has no caps on expenditures for these purposes.
Other Info	View executive summaryas a PDF 76 pp., 2002 View full report (except appendices) as a PDF.
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